By: AccuVal Associates, Inc.
During the past year, the U.S. hog industry has seen notable gains in futures contracts. While there have been some recent fluctuations in prices, the overall trend has been up for producers. From January 2008 through May 2011, the Producer Price Index (PPI) for fresh, frozen or processed pork increased 20 percent. At the same time, the U.S. city average price per pound of pork chops, other pork products (excluding ham and lunch meat), and ham (excluding canned ham and lunchmeat) have increased by 12 percent, 26 percent and 12 percent, respectively. The following figure illustrates the time trend of PPI and the price of pork products.
Exports to Japan, South Korea and China have been exceptional so far this year, helping U.S. markets gain considerable ground. In May, U.S. exports were 21 percent greater in volume and 30 percent greater in value than one year ago.
In 2009, the farm price of all hogs and the national base price per hundredweight were $41.98 and $41.24. The United States Department of Agriculture (USDA) projects that by 2020 these prices will have increased to $64.28 and $64.67. The following figure illustrates the USDA's projections for hog prices from 2009 through 2020, accompanied by hog inventory projections for the same time period.
Let's take a closer look at a few of the supply and demand trends that have been observed in the hog and pork industries.
The structure of the hog sector of the U.S. economy has changed significantly during the past three decades. Traditional farrow-to-finish operations raise piglets from birth to slaughter weight in a single location. But increasingly these farms are being replaced with large production facilities that specialize in a single phase of the production process. Under this alternative operational model, animals move to different facilities during each phase of production.
These structural changes of the hog sector have led to an increase in the number of larger hog operations and a reduction in the number of smaller operations. As evidence of this burgeoning trend, the USDA reports that the number of farms with hogs has dropped more than 70 percent during the past 15 years. At the same, pork production has increased. Large producers benefit from economies of scale, in turn, yielding higher output of pork and pork products. At the same time, barriers to entry are rising as new methods have increased the capital investment needed to enter the hog sector of the economy.
For pork, 6.5 pounds of feed are needed to produce one pound of meat, which is why corn and soybean prices are so critical to hog farmers. Amidst reports of a shortening global corn supply, prices have remained high in 2011 and domestic inventories at their lowest level since 1996, according to the Department of Agriculture. Summer weather patterns have the potential to impact prices further. Soybeans also rallied during the first half of July. During the past year, the most active soybean futures have climbed more than 40 percent.
According to the USDA, increased corn and soybean meal prices through 2011 and 2012 have driven the forecast for hog weights down. A lighter hog means less pork production. In June, the USDA reduced commercial pork production estimates for 2011 by 10 million pounds and the 2012 forecast by 40 million pounds because of these factors.
Contract production between hog growers or producers and hog owners is playing an increasingly important role in the hog sector. In 1992, hog operations with production contracts in place accounted for 5 percent of U.S. hog production. By 2004, this increased to 67 percent.
Contracts allow for different fee structures, thereby offering different profit channels. Traditional farrow-to-finish production methods are typically contract-free. Furthermore, contracts mitigate the harmful effects of information asymmetries (e.g., a hog owner sells a hog producer unfit hogs, just like a used car salesperson could sell an uninformed buyer a lemon), reduce transaction and coordination costs, and provide a certain degree of income stability for both parties to the contract.
Improved genetics, nutrition, housing and handling equipment, veterinary and medical services, and management has led to increased hog performance and efficiency gains stemming from improved operations and diminished production risk. A healthier, cleaner hog inventory reduces or may even prevent product recalls stemming from bacterial contamination of pork and pork products.
In February, the CME Group reported that U.S. per capita pork consumption fell by 2.2 pounds in 2010 to 48 pounds, its lowest level since 1997. Even still, consumption has remained relatively stable during the past 50 years.
According to the USDA, from 2011 through 2020, the U.S. will produce 234,286 million pounds of pork and pork products for an average of 23,429 million pounds per year. At the same time, the U.S. is projected to consume, on average, 19,278 million pounds per year or 192,178 million pounds in total by 2020. Over this time period, these figures yield growth in pork production and consumption of 10 percent and 8.3 percent respectively.
The U.S. is the world's largest exporter and fifth largest importer of pork and pork products. In June, the USDA revised its forecast for pork exports to 4,872 million pounds, 15.3 percent higher than the year before. During the first five months of the year, exports have already increased 18 percent. South Korea, Japan and Russia and China drove big increases in demand.
China is the world's largest consumer of pork. The country domestically produces a huge volume of the protein. However, recent conditions, including high feed prices and herd illnesses, have caused a big jump in prices. In June, pork prices in China increased 11.1 percent over the previous month. By mid-month, prices were 57 percent higher than a year earlier. This contributed to a recent surge in inflation, and now China is making moves to stabilize prices by increasing pork imports. During the first five months of the year, China purchased 130.5 million pounds of pork from the U.S., compared with 6.4 million pounds a year earlier. China announced in July that will continue its purchasing, buying up contracts for shipment August through October.
During the same timeframe, South Korea purchased 264 million pounds of pork compared with 106.8 million pounds a year earlier.
Japan accounts for roughly one-third of US exports, importing fresh chilled pork, frozen pork and fresh pork products. In Japan, fresh pork products are often used in various retail channels while frozen pork products are usually the primary input for other processed pork products.
But the largest export destination for U.S. hogs is Mexico, accounting for roughly 75 percent since the mid-1980s. U.S. hog exports tend to be mostly for slaughter, although roughly 10 percent are for breeding purposes. As of 2003, the entire hog inventory exported to Mexico has been solely for slaughter. Exports are also shipped to Canada. Despite recent expansions in domestic production, Canada is the third largest importer of U.S. pork products.
On July 7, 2011, U.S. hog futures declined as news of a stagnant US economy was released; the price of hogs for immediate delivery to slaughterhouses fell 2.3 percent. In a bearish economy, consumers are quite sensitive to price changes in the foods they eat. As other proteins, such as beef, chicken, fish, eggs and certain vegetables/legumes, experience fluctuations in price, demand for pork can shift. For example, if the price of chicken increases relative to pork, consumers who consume pork will likely demand more of it and vice versa.
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